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Are A-REITs Undervalued? A Closer Look After Reporting Season
With reporting season now over, it is worthwhile having a look at the Australian listed real estate investment trusts (AREITS), post the new property valuations that have come in to see what the market thinks.
See below data on the companies making up the S&P ASX AREIT 200 Index.
First up, many know that Goodman Group (GMG) is the domineering stock within the index. Just like Westfield was prior to its break up. But did you know Goodman has grown into such a monster that its market capitalisation is now greater than all the other constituents, combined?!
This is causing a grave headache for fund managers and is fraught with dangers if you just want to be a passive index investor. Goodman’s dominance skews every statistic in the REITS space. From price to book value through to yields and market beta.
Take out Goodman and the index looks like a reasonable value. Indeed, there is some serious discounting going on with the average (unweighted) price to NTA running at just 0.96. If you strip out the fund managers, the pure plays are trading at 82 cents to the dollar NTA.
There remains considerable variability with indexed AREITS. Some are trading as low as 55 cents in the NTA dollar! However, I note consensus distribution forward guidance has slipped from the last time we updated these numbers (May 2023). So, uncertainty/negativity surrounding forward rental income and so, distributions have increased.
Another notable pick up in reading the financials was the guidance by some REIT managers that they would like to bring their gearing down. Perhaps this is a little too late to act upon given higher interest expenses have already been fed into the P&L. All the same, lowering gearing is required given that a number of these entities are actually trading close to their gearing limits negotiated with their financiers. Now, how they do this remains to be seen. The first option is asset sales but the risk in doing that is if enough asset sales are transacted underneath book value, it may force the valuers into another round of capitlaisation rate increases.
The second option is rights issues, ultimately diluting existing units on issue. In 2008, most AREIT managers in debt trouble issued more equity, which did shore up their balance sheet; but at the same time, diluted investors and created value traps for those buying into what face value appeared to be heavily discounted REITS.
Based on what I have read on valuer’s adjustments, and assuming the risk-free rate stabilises at current levels, we can actually expect yet another round of capitlaisation rate expansion on the books. That will most likely happen with the Office REITs but don’t rule it out for the all-mighty industrial REITs which are trading on some of the lowest capitalization rates I have ever seen in my working career. On the other hand, if we do have a soft economic landing with the potential for a rate cut sometime in 2024, there is real value in the sector to be discovered.
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